It's still early in the year, but it's already looking like the biggest economic impact in 2022 will be related to the actions of the Federal Reserve. Shortages and supply chain issues related to the COVID-19 pandemic have sparked outsized inflationary pressures that haven't been seen in decades. To keep this inflation in check, the market is expecting multiple rate hikes that could result in an increase of 75 to 100 basis points in the Federal Funds rate.
While rate hikes are generally bad news for many stocks, one stock in particular looks to potentially benefit: Bank of New York Mellon (BK 2.05%). Let's take a look at why.
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Bank of New York Mellon has a different business model
Bank of New York has a business model that is quite different than other big banks. Most banks generate revenue by taking customer deposits that earn some level of interest and using it to make loans to other customers, charging interest for the service. The difference between what they pay in interest on their deposits and what they earn in interest on their loans is their net interest margin and is their main source of revenue. While the typical bank also has other sources of income, taking deposits and making loans is its main line of business.
Bank of New York Mellon is a trust bank, which means that a lot of its revenue is derived from fees. For example, Bank of New York Mellon is a big administrator of mutual funds. It holds the assets of the fund, handles inflows and outflows, and earns a fee for providing this service. Bank of New York Mellon also has other lines of business with wealth management, fixed income clearing, and corporate Treasury services.
The Federal Reserve is about to be an ally to the bank
Ever since the Federal Reserve cut the Fed Funds rate to near-zero, Bank of New York Mellon has been forced to waive fees on money market accounts. These are funds held by customers that earn interest based on short-term, highly rated, and liquid investments. When rates are 0%, they earn pretty much nothing. These funds cannot earn a negative return, so if the interest earned doesn't cover Bank of New York's fees, then it has to waive the fees. These fee waivers have been a big headwind for the company for the past two years.
To put the impact of the money market fee waivers into perspective, last year, Bank of New York Mellon's pre-tax earnings were $4.6 billion. Bank management estimated that the net cost of money market fee waivers in 2021 came out to $916 million. If the fees return, it would represent a 20% pickup to pre-tax earnings, even before taking into account the organic growth in other businesses.
Is the stock a good investment?
Bank of New York is expected to earn $4.68 per share next year, which puts the stock at a price-to-earnings ratio of 12.2 times. Earnings per share growth is expected to be 12%, so the stock is trading at a reasonable P/E-to-growth ratio. It pays a quarterly dividend of $0.34 per share, which gives it a dividend yield of 2.4%. Last year, the company also spent $1.2 billion on stock buybacks, which dwarfs the actual dividend in terms of benefit to the shareholders. Investors who are interested in exposure to the financial sector with limited credit risk might find Bank of New York Mellon attractive.
